Is Debt Consolidation a Good Idea? Pros and Cons of Debt Consolidation

Debt Consolidation a Good Idea - Pros and Cons

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IN THIS ARTICLE:
  • Learn about the pros and cons of different debt consolidation solutions.
  • A debt consolidation loan or a balance transfer are great options if you have excellent credit.
  • If you need payment relief, then a debt consolidation loan might not be affordable.

5 Different Debt Consolidation Strategies Pros and Cons

“Debt consolidation” is a general term, used widely by different people to mean different strategies for resolving debt. Deciding if debt consolidation is a good idea depends on the strategy, and just as importantly if it meets your needs.

When it comes to debt consolidation, there is no perfect strategy that fits every person’s needs exactly. What works best for you may be terrible for your neighbor. Beware people who say in online forums, “Don’t do {debt consolidation strategy X}. It’s terrible!” because they may not understand all of the positives and negatives for every strategy, and may not understand what works for them may not be a smart choice for someone else.

This article explains the situations where each debt consolidation strategy is a good idea, and where it is a bad idea. Here are the five common debt consolidation strategies we will discuss:

  • Debt Consolidation Loan
  • Credit Card Balance Transfer
  • Home Loan Refinance or Home Equity Consolidation Loan
  • Other Debt Consolidation Options

Debt consolidation loan pros and cons

A debt consolidation loan is a short term unsecured loan that allows you to pay off your credit cards and other bills, with just one monthly payment. It is essential to look at rates and fees because you want to make sure that you have affordable monthly payments and lower your costs. Debt consolidation loans are usually for between 2-3 years. 

Debt consolidation is a good idea if you...

  • want a more straightforward bill-paying schedule
  • have "good" to "excellent" credit and get a lower interest rate
  • want to boost your credit score

Debt consolidation is a bad idea if you...

  • don't control your spending and run up credit card debt again.
  • can't afford the monthly payments
  • pay a higher interest rate or high upfront fees

Balance Transfer loan pros and cons

You can also consolidate debt with a credit card balance transfer. Credit card companies offer 0% or low introductory rates for a limited time, frequently between 12-21 months. After that period, there is a high-interest rate. To qualify, you need a very good to excellent credit score. Look at the fine print and make sure you understand the upfront fees and the interest rates. A balance transfer is especially attractive if you can pay off your debt during the introductory period.

Consolidating debt with a balance transfer is a good idea if you...

  • can afford high monthly payments
  • have "good" to "excellent" credit and get a lower interest rate
  • want to pay off debt and save money aggressively

Consolidating debt with a balance transfer is a bad idea if you...

  • don't pay off the debt during the introductory low-rate period
  • run up new credit card debt
  • don't take into account the upfront fees

Home equity loan or cash-out refinance pros and cons

A home equity loan or cash-out refinance allows you to consolidate your debt into a small monthly payment. You will need to have at least 15-20% equity in your house after the new mortgage loan. You can take a mortgage for up to 30 years at a low-interest rate, which reduces your monthly payment. However, pay attention to lender fees and third-party fees.

A home equity consolidation loan is a good idea if you...

  • want to consolidate debt, even if you have only a fair credit score
  • want to reduce your monthly payment
  • can refinance your current mortgage at a lower rate

A home equity consolidation loan is a bad idea if you...

  • don't make your payments and increases the risk of foreclosure, 
  • pay high fees and carry the loan a short time
  • take on new debt and don't build equity in your home

Debt relief options pros and cons

There are other ways to consolidate your debt or your monthly payment. Two such programs are a debt management plan (DMP) and a debt settlement program.

Consumer Credit Counseling & Debt Management Plan

In consumer credit counseling, you enroll your debts in something called a debt management plan (DMP). The credit counseling provider will negotiate lower interest rates with each creditor, and then sets up a monthly payment amount. Typical DMPs take five years to complete. Credit counselors typically spend an hour with you working out a household budget to encourage savings instead of spending.

A debt management plan is a good idea if you...

  • want to consolidate your monthly payment
  • can stick to the program and pay off your debt
  • want to protect your credit

A debt management plan is a bad idea if you...

  • can't afford the monthly payments
  • pay high fees to the debt management company
  • don't qualify for lower rates

Debt Settlement Pros and Cons

Debt settlement is an alternative to consumer credit counseling and bankruptcy. Like credit counseling, in a debt settlement plan, you enroll your debts in the program. You stop making payments on the enrolled debt. Instead, you deposit funds into a designated account in your name. As the account grows, the debt settlement company negotiates with creditors. In the negotiations, the debt settlement company and the creditors agree to a lump-sum settlement for a fraction of the amount due.

A debt settlement program is a good idea if you...

  • are in financial hardship
  • want to reduce your monthly payment
  • want to save money and pay off your debt quickly

A debt settlement program is a bad idea if you...

  • want to protect your credit
  • can't afford the monthly payments
  • want to avoid collection calls
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